The Washington consensus is dead

Europe, China and the US have all rejected free trade and globalisation. Protectionism is back.

Illustration by Adria Fruitos

Have we witnessed the passing of the Washington consensus? Conceived in 1989, and based on the theory that free trade was the foundation of the wealth of nations, this held that underdeveloped nations should open themselves up to free trade and globalisation in order to amass their wealth. Any university student from the past few decades can probably recall how debates about the rights and wrongs of “capitalism” typically treated globalisation and free trade as synonymous. Few passing through seminar rooms in those years would ever have encountered a spectrum of economic thought without Adam Smith on one end and Karl Marx on the other.

Since China emerged as its major peer competitor, the US has behaved as though it never believed in the development philosophy behind the Washington consensus. Faced with a competitor willing to use the full arsenal of state-directed economic national policies, the US, first under Donald Trump and now Joe Biden, has returned to economic nationalism. Biden is employing state-directed industrial development, protectionism, the subsidised reshoring of manufacturing and trade-war strategies more aggressively and effectively than Trump. The EU is following the same path, increasing state spending on research and development with projects like Horizon Europe, industrial development policy for the whole Union, as well as relaxing state-aid restrictions for national industry. The global return to industrial policy began with China’s Made In China 2025 plan, announced in 2015, and was followed by the EU’s Green Deal Investment Plan in 2020. Then the US responded with the 2022 Chips Act and the Inflation Reduction Act.

This is a transitional moment, as one economic master narrative is supplanted by another. How can we make sense of it? The economic historian Erik Reinert has spent years reviving what he called the “other canon” of economic history and thought. Forsaken during the US’s postwar dominance (a period in which free trade benefited the unchallenged industrial leader of the world) this other canon is a method to reveal the world, past and present, in a different light. It was not imperialism or laissez-faire but state-directed policies that drove the economic miracles in 19th-century England, in post-Civil War America, Meiji Japan and the Wirtschaftswunder in 20th-century Germany. Among the most important economists in perfecting this school of thought were the German, Friedrich List (1789-1846), and the American, Henry Charles Carey (1793-1879). But the observable roots of their world-views go back much further.

During the Renaissance, Italian city-states achieved great wealth and success. Thinkers tried to formulate theories as to the cause of the success of these states, and their subsequent decline. Giovanni Botero (1544-1617) argued that the wealth of cities were built by what we now call manufacturing or “value added” – creating additional value to raw materials through manufacturing more complex goods for export. From a prison in Naples, Antonio Serra wrote his A Short Treatise on the Wealth and Poverty of Nations (1613), in which he argued that the active encouragement of manufactured exports, not the exchange rate, was the cause of wealth and the solution to economic decline, first theorising what we now call the effect of “increasing returns” activity.

[See also: Gramsci in Florida]

Tudor England had already taken these principles based on state-directed manufacturing and applied them on a large scale. England had once been a laggard importer of technology from the continent. Henry VII set England on its journey from relative poverty to a world-dominating industrial powerhouse when he started taxing raw wool and subsidising the manufacture of wool textiles for export. The repetition of this simple formula of discouraging simplicity and encouraging complexity was revolutionary in its effects. England’s resulting industrial take-off was so great that it eventually became a problem for the rest of the world, which not even Napoleon’s continental blockade between 1806 and 1814 could stop. How could any colony or independent nation compete with England’s head start when they were dependent upon England’s more advanced manufactured goods and locked into a raw materials economy? The Germans and the Americans later figured it out.

In fact, Adam Smith had warned America against protectionism and state policies to promote native industries, claiming that instead, free trade cosmopolitanism was the path to prosperity, writing in The Wealth of Nations (1776):

“Were the Americans, either by combination or by any other sort of violence, to stop the importation of European manufacturers, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like goods, divert any considerable part of their capital into this employment, they would retard instead of accelerating the further increase in the value of their annual produce, and would obstruct instead of promoting the progress of their country towards real wealth and greatness.”

The American republic’s future success was built on ignoring this advice, though when the US succeeded Britain as the world’s most powerful economy, Smith’s theory was dogmatically preached to less developed nations. It was America, with its ocean-sheltered geography, vast federal political union and advanced ideas from exiled continental influences, including German, French and Irish, that managed to build the national manufacturing model on the largest scale through the use of state protectionism. From Alexander Hamilton (1757-1804) to Henry Clay (1777-1852) to the more radical thinker Carey (Abraham Lincoln’s chief economic adviser), the devised American System employed tariffs to protect fledgling high-value native industries and a national investment bank for internal improvements in complementary infrastructure. By gaining currency and policy independence from Britain’s empire, disincentivising cash crops and raw material exports, while incentivising national industries through subsidies and protectionism, they constructed a national system so powerful that it would outgrow the British and all the others that came before it.

The transformation necessitated a war of independence and a civil war, but without it the US would never have become the world’s economic, military and political leader. The American School took all the right lessons from the industrial policy of European states and perfected them on a huge scale.

A significant breakthrough in German thought had been the publication of Friedrich List’s The National System of Political Economy (1841). The work functioned as a counter-history to the free trade world-view, showing the real route to national wealth, demonstrating how any less developed economy could break free of the colonial effects of free trade with an advanced economy. By documenting the role that industrial policy had played in creating national wealth, List’s book showed all laggard nations how to recreate the English manufacturing system on a national scale.

When List published his work in 1841, he wanted to make the Zollverein, a customs union of German states, into a single economic system organised by a political framework, with an industrial base. The concept of the European Economic Community, an enlarged federal economic union with centrally directed industrial development, originates with List. The German Historical School of the 19th and early 20th century developed an entire discipline from the study of development, rooted in this historicist method. In his study of the German historical school, The Visionary Realism of German Economics (2019), Reinert defines their approach as one of rejecting immutable natural laws, abstract axioms and individual self-interest in economics, instead stressing the role of institutions, law, policy and stages of development.

Marx opposed List’s vision as merely advancing German industrialists, even going so far as arguing that free trade was preferable to the more conservative and nationalistic goals of protectionism. But List saw the nation as a means for laggard nations to develop and escape the economic imperialist trap of free trade, which he argued benefited the industrial leader, Britain, to the detriment of less advanced nations.

Knowledge of how to transform a laggard nation into an industrial power spread around the world in the 19th century. In Japan, feudalism was replaced by the Meiji Restoration, a modernising regime that between 1868 and 1889 followed state-led strategies of rapid industrial development. State-owned industries were established, rail, iron and shipyards were developed and tariff autonomy later achieved in 1911. The catalyst for Japan’s transformation had been the arrival of the American navy, which shocked a feudal nation with its technological supremacy.

List had been translated into Hungarian, French, English, Swedish, Japanese, Russian, Chinese, Finnish, Spanish, among others. In Russia, even before the Bolshevik Revolution, the Tsarist minister Sergei Witte had been inspired by List’s ideas and begun implementing these methods, building up industry and the railways through state subsidies, as well as the subsidisation of key industries such as mining and steel, and raising tariffs while promoting exports.

Reinert has pointed out that the thinking behind both the de-industrialising Morgenthau Plan, the 1944 American proposal to dismantle German advanced industry as a means to permanently disempower it politically, and the re-industrialising postwar Marshall Plan, which was implemented, revealed a full awareness that national power comes from industrial power, requiring state direction. China would also look to national system strategies to escape feudalism, and some historians argue that List influenced Deng Xiaoping’s thinking during his leadership in the 1980s. Its industrial take-off, strengthened by nationalist anti-imperialist economics, is where the policy turn we are seeing in America today took root.

The South Korean economist Ha-Joon Chang wrote his 2002 book Kicking Away the Ladder: Development Strategy in Historical Perspective at the height of the Washington consensus. Chang remarked upon the similarity in how free-trade dogma served as imperial propaganda for the US, just as it had for Britain at the height of its power, and how laggard nations in Asia had used state-directed industrial policy to catch up. Reinert also wrote in terms of core-periphery relations in the EU that “when two nations at widely different technological levels integrate, the first casualty is the most advanced economic activity in the least advanced nation”. To maintain its dominance, the leading economy uses this “primitivisation” effect. But if another large nation achieves that state-directed industrial jump-start, it can potentially outgrow the other, just as the US did after its independence and just as many in America now fear China will do.

Which takes us to the complex situation we arrive at today. The strongest left-wing case against the EU was its fiscal conservatism and neoliberal undermining of state aid to industries. And yet a mixture of populist pressure and new geopolitical realities have led the EU to champion centrally directed industrial and technological development policy. Although there are ongoing disagreements between member states, as part of the Green Deal Industrial Plan the EU has also started to permit individual member state aid to boost investments for a faster development of renewable energies, while pouring funds into development for the whole Union. In an alternative 21st century, Brexit may have been prevented had that embrace happened sooner. This gives the world three vast economic and political unions: China, Europe and the US – each involved in a centralised, state-directed development race, with renewable technology at the forefront.

Critics of the “green” aspect of this development argue that, for Europe particularly, it may not be such a good idea to transition too quickly away from the fuels that built the Industrial Revolution because green technologies are not yet advanced enough to be truly renewable – they are still dependent on mining minerals. But policymakers seem confident that a great push like this is needed as non-renewable energy sources dwindle. Either way, the period of neoliberal globalisation is over and state-directed industrialisation is back.

Along with the many benefits of 19th-century development strategies came geopolitical competition, and then conflict. Is that also inevitable here? Biden and the European Commission president Ursula von der Leyen met last week to increase cooperation between the US and the EU, and form a closer bloc against China and Russia based on protectionism and joint supply chains for critical raw materials. This came after some panicking in Europe about the potential damage caused to European industries by the Inflation Reduction Act, with its large subsidies and import substitution.

Germany is also pledging greater Nato spending and Poland has announced it is sending fighter jets to Ukraine. British readers need not feel left out. Because now Aukus, the trilateral military defence organisation between the US, the UK and Australia is involved too. It has recently unveiled plans to cooperate on a nuclear-powered submarine defence system for Australia, and to collaborate on increasing the naval and undersea capabilities of all three members. In response, there is now some speculation about an “anti-Aukus” nuclear naval cooperation between Russia and China.

For all the talk of Western decline and decadence, it is extraordinary to see what a little geopolitical pressure can do. To establish pax Americana, the “old continent” had to make a more peaceful and humble liberal cosmopolitan anti-nationalism its official moral system, but is this not implicitly a civilisational alliance we are seeing? The Western world is returning to 19th-century development strategies, marshalling the power of an active state, in science, technology, industry and military power against an emerging counter-alliance of Russia, China and maybe Iran. The question is not whether it will lead to conflict or not. The conflict has already begun in Ukraine. The question is only how and when it will end and a new global settlement is formed.

[See also: Asia’s dangerous new arms race]